U.S. Treasury bond selling pressure has eased as investors grow doubtful that the energy crisis will prompt the Federal Reserve to raise interest rates, turning instead to government debt offering yields at their highest levels this year. On Friday, benchmark Treasury yields retreated after climbing to their highest levels since mid-2025. The two-year yield, which is highly sensitive to Fed policy expectations, fell by as much as 9 basis points to 3.90%, after earlier touching nearly 4.03%—its highest level since June.
This bond market rebound occurred even as crude oil prices broke through multi-year highs, disrupting the recent correlation between the two assets. Over the past month, investors have largely ignored the economic drag from rising fuel costs, instead pushing yields higher due to heightened inflation expectations. Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, noted, "The front end of the Treasury yield curve is no longer tracking energy prices as an inflation risk factor, but is instead focusing more on economic growth concerns and downward pressure on risk assets."
Longer-dated Treasury yields also pulled back from their yearly peaks. The 10-year yield still rose nearly 2 basis points on the day to 4.43%, after earlier surpassing 4.48% for the first time since July. Yields across maturities reached intraday highs as oil prices continued to climb, driven by U.S. military actions against Iran, now in their fifth week. Despite West Texas Intermediate crude futures settling at $99.64 per barrel—the highest level since mid-2022—short-term Treasury yields remained near their daily lows. The global benchmark Brent crude also closed at a multi-year high.
The resulting steepening of the yield curve broke a month-long pattern in which rising oil prices were accompanied by yield curve flattening, as investors had anticipated the Fed would respond to mounting inflationary pressures. In a report released Friday, Lyngen suggested that the day’s market movement signaled an approaching inflection point, where "the market’s reaction mechanism to further oil price increases will shift" toward driving a steeper yield curve.
Since February 28, when U.S. strikes on Iran disrupted regional oil supplies, Treasury yields have broadly risen alongside oil prices. Late Thursday, yields and oil prices briefly retreated after President Trump extended a pause on strikes against Iranian energy facilities by 10 days, though he expressed skepticism about the likelihood of a peace agreement.
Rising yields reflect concerns that increases in U.S. retail gasoline prices could feed into broader consumer inflation measures, potentially preventing the Fed from implementing the rate cuts that were widely expected before the conflict began. John Briggs, head of U.S. rates strategy at Natixis, noted that as long as the Strait of Hormuz remains closed, investors will worry about "inflation and the possibility that central banks will respond in a manner similar to 2022." The oil shock following the 2022 Russia-Ukraine conflict contributed to the post-pandemic inflation surge, ultimately leading the Fed to raise rates by more than five percentage points by mid-2023.
Macro strategist Michael Ball commented, "The next move in the Treasury yield curve is more likely to be steepening, led by a potential reversal in front-end yields. These yields have been aggressively pricing in oil-driven inflation but have under-priced the impact of rising energy costs on growth and the labor market."
Market expectations for inflation over the coming year, though down from last week’s highs, have surged from around 2.2% at the start of the year to above 3%. Swap contracts reflecting expectations for future Fed rate decisions no longer imply any rate cuts this year and now price in more than a 50% chance of a rate hike.
Molly Brooks, rates strategist at TD Securities, observed, "The market has completely shifted. Participants have gone from asking when the next rate cut will come to pricing in a potential hike by 2026." The Fed cut rates three times last year in response to labor market weakness. Although those concerns have largely subsided, February employment data still came in weaker than economists had expected.
The March jobs report is scheduled for release next week on April 3 under unusual market conditions. U.S. stock markets will be closed for Good Friday, which is not a federal holiday. Bond market trading hours will be shortened, and investors will have only limited time to react to the data.
Friday’s moves put the U.S. Treasury market on track for one of its worst monthly performances in nearly five years. According to a relevant Treasury index, the market had fallen 2.36% month-to-date as of March 26. If this decline holds, it would mark the weakest month since October 2024.
Citi economist Andrew Hollenhorst noted in a report that upward pressure on Treasury yields also stems from the prospect of increased U.S. government borrowing—needed both to finance war costs and to refinance existing debt at higher interest rates. This week’s auctions of two-year, five-year, and seven-year notes all concluded with higher-than-expected yields, reflecting the average rate investors are demanding to meet the U.S. government’s financing needs. The three auctions raised a combined $183 billion. This marked the worst monthly performance for these maturities since May 2024, when traders were also scaling back bets on rate cuts.
Hollenhorst wrote that the Treasury auctions "serve as a reminder that fiscal challenges intensify as interest rates rise," pointing out that "large deficits are easier to finance when Fed rate cuts are expected," whereas currently, "defense spending expectations are increasing."
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